The role of insurance in health care, part 1
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Transcript of The role of insurance in health care, part 1
The role of insurance in health care, part 1
Today: Why health care is important to study; The advantages and disadvantages of private insurance
Unit 3 begins now
Unit 3 health care & income redistribution Chapter 9 (this week)
Why health care is important to study The role of health care insurance in the United States
Chapter 10 The role of government in the health care industry
Parts of Chapter 11 Social Security issues, including long-run problems
Parts of Chapters 12-13 Income redistribution issues
Today
Begin Chapter 9 Why is health care important? How health insurance is administered in the
United States Advantages and disadvantages
Risk smoothing with health insurance The problems of adverse selection and moral
hazard Deadweight loss of health insurance
Why is health care important? Health care has steadily used up more of the
US GDP percentage share over the last 50 years This trend will likely continue in due to the
retirement of the baby boomer generation Currently, about 1 out of every 7 dollars of
GDP is used to spend on health Estimate for 2017: 1 out of every 5 dollars
See also Figure 9.1, p. 181
Why is insurance important to study? Private health insurance provides over a third
of all health care funds in the US Small improvements in efficiency of health
care delivery could lead to billions of dollars of savings
See also Figure 10.2, p. 207
How health insurance works
Insurance premium People buy insurance due to risk aversion and often get
reduced cost through work Working Americans usually buy insurance from employers
Companies sell insurance since they do not have to sell at the actuarially fair price
Specified benefits Full insurance? Co-payments and/or coinsurance? Deductibles?
Growth of employer-provided insurance Policies during WWII
Wage and price controls resulted in non-wage incentives to workers
1940s: Private health insurance grew significantly 9.1% of Americans in 1940 50.3% in 1950
Tax structure Health insurance is not taxed
Growth of employer-provided insurance Adverse selection
If everybody has health insurance, there are no adverse selection problems
Low administrative costs Group plans in a big firm could have one worker
taking care of all employees
Types of insurance
Cost-based reimbursement (fee-for-service) Managed care arrangements
Health Maintenance Organizations (HMOs) Preferred Provider Organizations (PPOs) Point-of-service (POS)
Managed care arrangements try to keep costs down Co-payments, deductibles, coinsurance, oversight
of services
Insurance, the old way
Cost-based reimbursement Most health care administered
this way until the early 1980s Provides payments for all
services Moral hazard problems
No incentive to keep health care costs down
Increased health care costs to society
Leads to higher premiums
Insurance for your generation Today’s insurance plans have different
methods to keep costs down Many employees have choices of different
plans offered by the employer HMO plans PPO plans POS plans
HMOs
Little flexibility All services must be approved by the HMO You typically cannot consult the doctor of your
choice in case of catastrophic illness Lower in cost than other comparable options Often accepts fixed payment per patient
Known as capitation-based reimbursement Example: Kaiser Permanente
PPOs
More flexibility in choice of doctors “In-network” costs are lower
A doctor in the network accepts a lower fee Doctor gets steady supply of patients
“Out-of-network” costs are much higher Higher deductibles and/or co-payments You can often use a world-class hospital if you are
willing to pay part of it
POS plans
Similar to a PPO Main differences from a PPO
Each patient has a primary physician Primary physician oversight keeps costs down relative to
a PPO The primary physician provides referrals to see
specialists
Dealing with job lock
Job lock If a new job does not offer insurance due to a pre-
existing condition, the worker will stay at the old job
Health Insurance Policy Portability and Accountability Act of 1996 (Kennedy-Kassenbaum Act) Provides provisions to reduce job lock Mixed success
One idea on restructuring benefits Sharing costs between patient and insurer can help
keep costs down A health insurance model to try to reduce health
care demand Provide a yearly fund to each person or family
Carries over to the following year if not used After the yearly fund is used, up to $5,000 of expenses
must be made out-of-pocket After out-of-pocket expenses are paid, 90% of expenses
are covered Insurance for years with truly high expenses
Pooling and risk
Pooling Risk of a single person or family is high Risk of insuring a big population is low
Note Law of Large Numbers Assumes independent risk from person to person
Recall expected value Expected value (EV) = (probability of outcome 1) *
(Payout in outcome 1) + (probability of outcome 2) * (Payout in outcome 2) + … + (probability of outcome n) * (Payout in outcome n)
Why buy insurance? ExampleInsurance Options
Income Probability of Staying Healthy
Probability of Getting
Sick
Lost Income if She Gets
Sick
(A) (B) (C)
Income if She Stays
Healthy
Income if She Gets
Sick
Expected Value
Option 1: No Insurance
$50,000 9 in 10 1 in 10 $30,000 $50,000 $20,000 $47,000
Option 2: Full Insurance ($3,000
premium to cover $30,000
in losses
$50,000 9 in 10 1 in 10 $30,000 $47,000 $47,000 $47,000
Actuarially Fair Insurance Policy
Expected values are equal
Why buy insurance?
Income
Util
ity
20,000 47,000 50,000
UA
UC
UD
UBD
C
B
A
• Expected Utility
• Risk Smoothing
• Certainty Equivalent
Note: Graph is not to scale
X
Willingness to pay (WTP) for insurance is 50,000 – X, which is more than $3,000
Loading fee
In the last example, the actuarially fair premium is $50,000 – $47,000, or $3,000
Insurers charge a loading fee, which is the amount over $3,000 in this case
Average loading fee: 20 percent
More on risk aversion: See Figure 9.3, p. 185
Another problem: Adverse selection Adverse selection problem: Suppose no
employer health benefit When potential insurance buyers have a choice of
whether or not to buy insurance, people that are more likely to need the benefits will buy the insurance
Insurance companies do not know who will be in a high risk category
Example
6 people at a firm Spending if somebody gets sick: $10,000 3 people have a high risk of getting sick
10% each Expected spending is $1,000 3 people have a low risk of getting sick
5% each Expected spending is $500 Notice average probability of getting sick is
7.5% No employer-provided contributions to health
care
A naïve offer
Suppose the insurer offers a premium that is 7.5% of $10,000 $750
Who gets insurance under these conditions? High-risk people with certainty ($1,000 > $750) Low-risk people?
Only if WTP for insurance is at least $750
What happens? Insurer loses money due to some low-risk people
not insuring
What really happens?
The high-risk people will be the only people willing to buy insurance in equilibrium
The insurer offers a premium above $1,000 that gets all three high-risk people to insure Premium above $1,000 can be charged due to
risk aversion Loading fee helps the firm pay its administrative
expenses
Solving the adverse selection problem Suppose that the employer offers a $350
contribution to each person that buys insurance
Avg. spending if everyone gets insured: $750
Insurer only needs to charge $400 to break even (excluding administrative costs)
What if the insurer offers a premium of $480? Everyone will now insure, since the expected
spending of each person is at least $500
Un-solving the adverse selection problem The opposite of the above situation occurred
at Harvard in 1995 Reduced contributions to generous health plan “Death spiral” led to the eventual elimination of the
generous health plan Does this mean that government intervention
should occur? Pro: More equity Con: Not efficient
One more problem: Moral hazard Moral hazard problem: People are more
likely to use health care when their share of payments is small or zero
Two moral hazard issues Riskier activities Use of health care that has MB < MC
Moral hazard issues
Riskier activities Skydiving Bungee jumping Poor eating habits Decreased exercise
Use of health care that has MB < MC This is due to patient not
paying the full cost of services provided
More on moral hazard on Wednesday What other problems occur when patients do
not have to pay the full MC of their care? What reforms to health care can be made to
solve these problems?
Summary
Health care spending is a significant part of GDP New methods are being used to try to keep costs
down Many health care options exist for workers People buy health care insurance due to risk
aversion Adverse selection and moral hazard are
problems that prevent efficient use of health care
Stay healthy